Monday, March 4, 2013

The Financial Revolution in Medieval and Early Modern Europe

It is well known that a financial revolution occurred in European economies from the late Middle Ages onwards. Both the financial system and financial asset markets became much more complex and recognisably modern.

I sketch that revolution below in these main points:

(1) There was a renewed religious opposition to usury from the 13th century, especially from the Franciscan and Dominican orders, and affirmed in the Four Lateran Council (1215). This renewed outbreak of religious hostility to usury forced secular authorities to enforce the laws against the interest-bearing money loans, and, paradoxically, the open money loans at interest that had been seen in earlier Medieval times tended to disappear (Munro 2003: 507). The campaign against usury culminated in the early 14th century, and is reflected in Dante’s Divine Comedy, where usurers are imagined in the lowest, worst depths of hell (Munro 2003: 510).

(2) The harsh anti-usury culture encouraged financial innovations to evade the laws. Private debtors and creditors disguised their money loans at interest in the form of sale contacts for some good sold below the present market price and later resold at a higher price (the so-called contractus mohatrae). Another invention was the bill of exchange, a debt instrument where interest was disguised by charging a higher exchange rate in favour of the lender (Munro 2003: 542).

Another area where finance became much more developed was in government borrowing.

Often limited at first to city states and municipal government, government borrowing was one of the causes of the financial revolution of Early Modern Europe.

In Northern Europe, city and municipal governments began to issue special financial contracts, as follows:

(1) the bail à rente, the sale of real estate or fixed property in return for a perpetual annual income, and

(2) the constitution de rente (“annuity purchase”) or rente à prix d’argent (“annuity for money”), by which the property holder sold the right to receive a fixed annual income from his property or real asset to some investor, even though the original property holder retained the ownership rights to his property (Munro 2003: 519). This was the most significant innovation for the financial history of Europe.

It was in Holland and Spain that financial instruments of the second type became very significant: in Holland, there were renten issued by the Dutch provinces to raise revenue, and in Habsburg Spain the monarchy issued juros al quittar, perpetual but redeemable instruments yielding 5% in the later 16th century (Munro 2003: 536).

Both these instruments were assignable or transferable, and it was the development of secondary asset markets for these debts that can be seen as a fundamental cause of the invention of modern financial markets: the Antwerp bourse (opened in 1531) and Amsterdam bourse (established in 1608) were centres for the trading not only of commodities, but also of Dutch renten and Spanish juros al quittar, the precursors of modern government debt (Munro 2003: 541–542, 557).

By the 18th century, government debt annuities – such as the British “Consolidated Annuities” or “Consols,” a form of perpetual bond – had become a major part of financial asset markets and a source of collateral for merchants and industrialists (Munro 2003: 560).

(3) the next step was the creation of legal sanctions for and protections of the negotiability (or transferability) of debt.

This development was aided by the creation of laws for negotiability of bills of exchange, which originally had no legal standing (Munro 2003: 545).

An important step was the emergence full negotiability of debt instruments: this requires that a debt instrument can be made “payable to bearer” or “payable to order” without the necessary consent of the original debtor, so that third parties can accept it as a means of payment and legally enforce their claims on the original debtor (Munro 2003: 546).

Between 1537 and 1543, this was accomplished in the Netherlands, and even earlier in England for bills of exchange in the case of Burton vs Davy (1436) (Munro 2003: 551, 554).

A further step in England was to make all internal promissory notes fully negotiable in 1704 (Munro 2003: 556).

(4) the abolition of Medieval laws against usury soon followed: interest of up to 12% per annum was allowed in Holland in 1543, and up to 10% in England from 1545 (although this was temporarily repealed from 1552–1571; Munro 2003: 554).

(5) The last element of modern financial systems is deposit banking on fractional reserves: this emerged in the northern Italian city states from the late Middle Ages, Holland from the late 16th and early 17th centuries, and England in the mid-17th century (Munro 2003: 547–548).

A final observation I will make is that assignable and then fully negotiable debt instruments, when transferred to third parties and used to effect purchases of goods, have added to the money supply of Western economies for centuries: the West, ever since the Middle ages really, has had an elastic money supply.

Long before fractional reserve banknotes, bills of exchange and promissory notes have been used alongside strict commodity money.

Addendum
There is a fascinating post here by Matias Vernengo on the economic history of the Soviet Union:

32 comments:

I have to say I don't think lending money at interest is a bad thing in and of itself.

At exorbitant rates, yes; and by unscrupulous people to vulnerable people who need, say, basic things that ought to be available without going into debt, yes.

A certain amount of the lending that goes on might be immoral, yes.

But if you get a loan to buy a house at a reasonable rate of interest and you can easily afford to pay it back, is that bad? It allows you to buy a house without having to wait years saving the money up, and to avoid just throwing your money away on apartment/housing rentthat is lost to a rentier.

You lose some money to your creditor/lender rentier as interest, yes, but not as much as to a landlord.

You can't separate the normal business activity from the credit. Indeed, whenever one sells something in advance - or gets paid in advance - there arises an implicit credit. Usury is just a credit made explicit.

I wonder if the development of these financial instruments -- which no history professor ever told me about -- provides part of the answer to the question that is often asked in Chinese and Middle Eastern history courses: why did Europe break ahead of these cultures?

My recollection is that Islam still condemns usury. I think traditional China during the great dynasties may have banned it as well. The advancement of Europe, which had been lagging behind these other nations in science and art for centuries, occurred around the time that you discuss. It would be characteristic of the witty turns of history if Europeans' "vice" contributed in a meaningful way to their development of modern science and technology (though their conquest of the rest of the world is a decidedly unfunny story).

" There was a renewed religious opposition to usury from the 13th century, especially from the Franciscan and Dominican orders, and affirmed in the Four Lateran Council (1215). This renewed outbreak of religious hostility to usury forced secular authorities to enforce the laws ..."

Interesting LK.... I am currently watching the selection of the new Pope with interest in this regard... Benedict was well focused on economic justice of late imo... we'll see if this remains the trend out of the Vatican (or not...)

(1) Arestis and Howells cite estimates of the money stock: from 1526 to 1561 it was supposedly stable at £1.45m (p. 11), but is that just the commodity money base or the broad money stock? My immediate question would be: if this is just the base money, did money supply grow once you try and define some kind of broad money stock for this period? (factoring in the type of credit money discussed above).

(2) What Arestis and Howells postulate is a rise invelocity owing (I assume) to greater demand from rising population. They appear to be using Fisher’s Equation of Exchange (MV = PT) - though I think many economists would argue that the Cambridge Cash Balance equation is the superior version of the quantity theory - that is, if you're really going to use the quantity theory for monetary analysis of inflation.

Nevertheless, I think (as far as I know!) the whole question of the causes of the "Great Inflation" is still debated.

For one thing, wasn't it a European-wide phenomenon?Unless you can show the same factor (inflation caused by growing population and lagging output in other European nations - which might be true), I suspect there would questions asked like this: does this theory really explain why inflation happened in the rest of Europe too?

(4) Another important discussion of the Great Inflation is D.O. Flynn, “Use and Misuse of the Quantity Theory of Money in Early Modern Historiography”, in E. van Cauwenberghe and F. Irsigler (eds.), Münzprägung, Geldumlauf und Wechselkurse: Akten des 8th International Economic History Congress, Section C7, Budapest 1982 = Minting, Monetary Circulation and Exchange Rates. Trier, 1984, 383–417.

First, Flynn rejects Fisher’s quantity theory.

He argues that the market value of silver fell to 1/3 of the original value in the course of the 16th century, because of the steep fall in its long-run cost of production. That is, the market value of silver was determined internationally and, since Europe was basically on a silver standard in the 16th century, a fall in the market value of silver caused price inflation in all silver-content prices.

Whether modern econonists find this convincing or not, I don't know.

(5) yet another modern study is David Hackett Fischer's The Great Wave: Price Revolutions and the Rhythm of History (1996), though I can't recall his actual explanation of the 16th century price revolution offhand.

"Both the shortage and the rise invelocity to which it gave rise are confirmed by estimates of the money stock..." (pp11)

(2) I've always found the cash balances equation unwieldy, but its all the same...

(3) The population squeeze on agricultural supply was probably across Europe. After population tanked due to the Plague among other things** it bottomed out and then surged. It would not be surprising if this caused inflationary pressure.

If population pressures were Europe wide, then that looks like a persuasive cause of the inflation - or at least one major cause - given the relatively inflexible output.

I've read Niall Ferguson's Ascent of Money. There was some mildly interesting stuff here and there (e.g., on the origins of bond markets), but in general it was one-sided, gives a very poor treatment of credit money, and descends into the worst neoliberal apologetics in many places.

I have it on good authority from very open-minded economic historians that Ferguson's work is untrustworthy. One compared it to another neoliberal historian's work (David Landes) and said (not quoting verbatim): "Landes is an historian. You can see his blind spots and you can disagree with his conclusions, but I trust his facts and I trust that he is sticking to them closely. I don't trust Ferguson. His interpretations are either too wild or his facts are dubious and not carefully selected. It's just story-telling". This historian refuses to put Ferguson on the reading list for class. Not surprising.

Amazing... a continuous stream of coercion and price controls by central authorities making decisions arbitrarily and against the wishes of voluntary actors has led to the system of finance and banking we have today!I completely agree with this post.That the same policies in Asia and Africa led to a stymied economic development could not be more true.

(1) people were forced/coerced to use promissory notes and bills of exchange, despite the fact that these things were invented and used freely by private sector agents?

(2) that FR banking was *forced* upon people, even though the private sector invented FR banking and people had the free choice of using FR banks or not?

(3) that the Antwerp and Amsterdam bourses were *forced* upon an unwilling public, even though these things were organised and used freely by the private sector?

(4) that abolition of Medieval laws against usury were *forced* on an unwilling public?

(5) that governments just *forced* people to buy all their debt, when the whole trend of modern bond markets was actually free offering of government debt to the public, who could buy it or shun it?

And lastly are you saying that countries that have no modern financial system (e.g., credit instruments, secondary financial asset markets, well-developed commercial law protecting creditors, and FR banking) actually have better economic growth than those that do?

In fact, one wonders whether you gave your mindbogglingly stupid comment even 5 seconds of thought before posting it here.

"There was some mildly interesting stuff here and there (e.g., on the origins of bond markets), but in general it was one-sided, gives a very poor treatment of credit money, and descends into the worst neoliberal apologetics in many places."

Neoliberal, huh? When are you going to learn that not all neoliberals are the same? I for example, I for example, am a center right keynesian/monetarist/friedmanite who HATES fiscal and monetary austerity Your childish attempts at creating "neoliberal" as a bogeyman are amusing, but also pathetic

EVERYONE uses models. You, me, everyone, to simplify and make the world more understandable. Some neoliberals get deluded into thinking their models are accurate. Others like, PK, just use them as a mental tool, a springboard, not as an ending point.Now tell me. What the heck is wrong with that

Well, do you at heart believe that if only wages and prices were flexible we would have convergence towards market-clearing general equilibrium (that is, DSGE is basically what you use as a "mental tool")?

If you think that, then your model is plainly wrong and even using it as a mental tool is liable to lead to the wrong conclusions about what policies need to be adopted for real world market economies.

E.g., if you think wage flexibility is the solution to involuntary unemployment, what about the problem of debt deflation?

Wages and prices are clearly NOT flexible in the real world. I understand that. In that case, expansionary monetary and fiscal policy is clearly called for. But, If wages, prices, AND DEBT were flexible (How could debt be flexible? Have liberal default laws. Mark debt down without penalizing the middle classs. Adjust debt to downward falls in incomes.) Than YES, markets WOULD clear. (Don't talk to me about subjective expectations. Onces prices hit a bottom and are expected to rise, that creates expeted inflation, and economies recover, At least in theory.)But things like the money illusion and a whole host of other things prevent this, so my prescription is similar to yours. EFP (expansionary fiscal policy) I RECOGNIZE the limits of my model in the real world . How exactly, am I misled by it?

Neil Wilson

"Ed,

You should know that I am a modeller. It's how I earn a living.

The neo-liberal model is wrong. It is based on beliefs that are wrong. It's predictions are wrong. It's prescriptions are wrong.

The level of wrongness can only be matched by the more esoteric beliefs of the world's religions.

Talk about looking a gift horse in the mouth."

LOL. OF course you would say that. Let's take something like a perfectly competitive market. Something which is clearly "wrong" in its description of the real world. What the neoliberal model says is "if the PCM were true, than x....". and that, my friend, is true. It doesn't REALLY say that the PCM is literally true. (Or homo economicus... or a whole host other things) What you then do is to measure how different the result would be if you didnt have PCM, and create A MORE COMPLETE model for that, something like monopolistic competition. P.s. What do you think "neoliberal" economists have been doing, for the past decades, especially left leaning NK economists like Brad Delong and PK.?Of course theyve been adding frictions to their models! Tell me, is New Trade Theory "wrong" because not all of its descriptions match the real world? (EG, no transportation costs)

And I suppose you subscribe to the idea that money supply is exogenous as well? Well, again this is wrong: money supply is endogenous and controlling inflation is mostly a question of buffer stocks and income policy.

"Don't talk to me about subjective expectations"

And why not? Rational expectations is tripe, and without looking at uncertainty and the nature of expectations you will never understand real world market economies.

The direction you look at something alters the view of what is actually happening.

It's not a matter of adding colour and detail to the painting. It's a matter of moving the easel to somewhere else. And that fundamentally changes the picture."

Again, of course you would say that. i guess this is where you and I part company. I've "moved the easel," and that fundamentally changes the picture to gibberish for me. For example, I've never been able to understand how MMT people would control demand pull inflation. (LK's buffer stocks make absolutely no sense whatsoever, because those can only solve COST-PUSH.)

LK."This is exactly why we have a fundamental disagreement," Indeed. .."and why you are misled by your model."

Of course you would say that

"First, Post Keynesianism, following Keynes himself, argues that, even if wages and prices were perfectly flexible, we could still have involuntary unemployment.

You need the following three fundamental axioms to make your neoclassical theory work, but they are all false:

First, I reject neutral money in the short term, any fool, even those trained at Chicago (with the possible exception of Eugene Fama) knows that injections of money affect immediate output. For long term money neutrality to be false, you would have to say that the velocity of money, endogenous or exogenous, has no effect whatsoever on inflation, which is clearly false. (Ok, so maybe the correlation between increases in MV and increases in prices isn't EXACT in the real world, but it still is quite strong. Look at cases of irresponsible governments, that engaged in demand pull hyperinflation.) I would therefore say that neutral money in the long term isn't LITERALLY TRUE, only approximately true, but still very close.

The only thing I would say in regards to the gross substitution axiom is: whose fault is it that the private sector cannot reproduce money easily and is starved of liquidity? If the central bank and treasury do their jobs, we needn't worry about liquidity preference. The Federal reserve, through its inaction, let a garden variety recession turn into the G.D. And that is also the explanation, on a much smaller level, for the Great Recession. Oh and by the way, falling prices by themselves are not how markets clear. Falling prices+a definite bottom,+ inflation expectations+ low, easy to default debt+ wage and price flexibility leads to markets clearing in that theory. See, what happens when prices and wages fall (in the absence of debt) is more purchasing power is created, "real" money stock if you will, rather than nominal. So maybe at the individual level the GSA isn't true, but at the societal level it can be. Private actors may be forbidden to copy dollar bills, or pounds, but they can create more purchasing power.

The strict ergodic axiom doesn;t even hold in the physical sciences, let alone the social ones. The whole issue is one giant straw man that pk's love to throw at neoliberals. Anyway, just because there are degrees of fundamental uncertainty, does not mean we cannot know anything, or take steps to mitigate those risks.

"And I suppose you subscribe to the idea that money supply is exogenous as well? Well, again this is wrong: money supply is endogenous and controlling inflation is mostly a question of buffer stocks and income policy."

Money has an exogenous, and an endogenous element. to deny both would be foolish. do you deny that central banks engage in OMP's treasuries around the world create physical currency with their printing presses? As I said before, buffer stocks, MIGHT be useful to mitigate cost push inflation, but not demand pull. And incomes policies are insane. Theyve never worked and never will work.

"And why not? Rational expectations is tripe, (incomplete) and without looking at uncertainty and the nature of expectations you will never understand real world market economies.

Expectations is something I understand very well, but something you do not seem to. Maybe part of the reason why investors hold off buying is because they expect prices to fall further. I think that might tie in with the Post Keynesian emphasis on "uncertainty" But when prices hit a bottom, and start to inch up, People start to buy because they think prices will rise in the future. THATS how the market really clears, and not by cutting workers real wages. It also takes care of you uncertainty and S.E. problem.

Oh and by the way, i solved your debt deflation problem in your previous post. Because you have an ideological agenda, and ignore theories and evidence that contradict it, .you'll ignore it. That's fine, but don't ever accuse me of not answering any of you questions. :-)

"Excepting policies like QE or monetizing a deficit, even normal central bank operations are usually just responses to private sector demand for money.

Even base money is endogenous to a considerable degree. What is exogenous is the base interest rate."

You're confusing demand and supply. The government sup pies (hopefully) and the private sector demands. The supply process itself is exogenous.

"I disagree. Monetary policy might have prevented financial sector collapse in the 1930s (if only it had been done properly), but it would not have prevented considerable GDP collapse.

As Keynes said: the idea that QE will stimulate private investment under shattered expectations is like "trying to get fat by buying a bigger belt."

Trillions of dollars of QE in the US hasn't induced the necessary level of private investment to cause full employment, and it is as simple as that."Its remarkable how close u sound to anti-Keynesians who say, "we've tried fiscal stimulus, and it hasn't worked"You have to keep in mind the size of the Us Economy and financial markets. A paltry trillion, her, some billions there, will do NOTHING.What is needed is something radical. A trillion each MONTH, until the entire US national debt is bought up. or the economy recovers. Will you at least acknowledge that will create a massive upsurge in A.D.?